CHAPTER V INDIA S TRADE POLICY AND PERFORMANCE

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1 CHAPTER V INDIA S TRADE POLICY AND PERFORMANCE 5.1 Introduction 5.2 India s Trade Policy : An Overview 5.3 Phase wise Analysis of Trade Policy & Performance 5.4 Summary 5.1. INTRODUCTION It is observed that most of the third world countries had a colonial past and their economies were exploited by colonial powers. The colonial powers used foreign trade as an instrument of exploitation in these countries. Development Economists of 1940s and 1950s like Raul Prebisch, Hans Singer, Gunnar Myrdal, Ragnar Nurkse, and many others pointed out that the colonial powers were the consumers of primary goods and producers of manufactured goods, while the colonies ( the underdeveloped countries) were mainly consumers of manufactured goods and producers of primary goods. As the prices of primary goods were declining and that of manufactured goods were increasing, there was a deterioration in the terms of trade over time of underdeveloped countries. Therefore, many underdeveloped countries which became independent after the Second World War viewed foreign trade and investment with suspicion. Hence, they focused their attention towards domestic markets. Many of them adopted a programme of industrialization on a large scale to build up their industrial sector and reduce their dependence for manufactured goods from developed countries. Thus, these countries mainly followed inward oriented policy and had a pessimistic view with regard to exports. 140

2 However, during and after 1960s many developing countries adopted programmes of import liberalization and export promotion and achieved remarkable success. As a result economists as well as international agencies like IMF and the World Bank started advocating import liberalization and export promotion as a solution for many economic problems of the developing countries Trade Policy On analytical grounds, trade policy can be broadly divided into two groups (a) Inward oriented and (b) Outward oriented. (a) Inward oriented policy:- An inward oriented strategy is the one in which trade and industrial incentives are biased in favour of production for domestic market over the export market. Thus, an inward oriented policy is often designated as the import substitution strategy. (b) Outward oriented policy : - On the contrary, an outward oriented strategy is the one in which trade and industrial policies do not discriminate between production for domestic goods and foreign goods. Thus, an outward oriented strategy is often designated as the export promotion strategy. As remarked by World Bank in its World Development Report (1987) Inward oriented regimes are generally characterized by high levels of protection for manufacturing, direct controls on imports and investments, and overvalued exchange rates. By contrast, outward orientation links the domestic economy to the world economy. 1 The solution to the problem of BOP for a country depends on the trade policy / export import policy of the country. Hence, a systematic study of BOP of a country should take into account the changes in the trade policy of a country over a period of time. 141

3 5.2 INDIA S TRADE POLICY: AN OVERVIEW In a broader sense, after independence for almost forty years or so India adopted inward oriented strategy. The basic rationale behind it was that it would help rapid industrialization through import substitution and at the same time save valuable foreign exchange. This strategy covers the period from First Five Year Plan ( ) to the Seventh Five Year Plan.( ). This period is considered as the period of Licence Quota Raj wherein there was a controlled and restrictive environment. However, the decade of 1990 is marked with a near U turn as India adopted gradually a path of economic liberalization. It followed the policy of Liberalization, Privatization and Globalization (LPG) to solve its BOP and related problems. A series of economic reforms were introduced in various sectors to tackle the BOP and other problems. Hence, the Indian economy which was a closed economy for almost forty years now became relatively more open posing challenges for macroeconomic management. Thus, from 1990 onwards India adopted an outward oriented strategy which can be considered as a significant turnaround from the earlier period. The adoption of outward oriented strategy was a major departure from the relatively protectionist trade policies pursued in earlier years Phases of India s Trade Policy There is no doubt that in the broader sense of the term India followed an inward - oriented trade policy after independence till However, an in depth analysis of India s trade policy shows that there were certain shifts in policy stance from time to time. Taking this into account trade policy of India can be broadly divided into the following phases (1) Phase I Import Restriction and Import Substitution (From 142

4 1950 s to 1970s),(2) Phase II Export Promotion & Import Liberalisation (From 1970s to 1990s),and (3) Phase III Outward Orientation (From 1990 onwards) PHASE WISE ANALYSIS OF TRADE POLICY & PERFORMANCE a Phase I Import Restriction and Import Substitution (From 1950s to 1970s) At the time of independence, the Indian economy was a predominantly agricultural economy using primitive production techniques and was completely shattered by centuries of colonial plunder. There was a need for planned economic development with the state playing a leading role. At that time there was also a debate among the economists as well as policy makers with reference to the choice between either import substitution or export promotion strategy needed for planned economic development. Moreover, in the early fifties, neither there was any empirical evidence of the relative advantage of one or the other strategy, nor the experience of developed countries in the pre war period could provide any appropriate guidelines for the choice of the policies. As a result, the Indian planners had to shoulder the special responsibility taking their own independent decisions on development and trade strategies. Under such circumstances, it was the pragmatism, initiative and even the urge for socioeconomic transformation of the leaders and the policy makers played an effective role in the choice of the strategies. Hence, for the purpose of economic development India adopted Economic Planning supported by Nehru s vision. As the country adopted Economic Planning for the purpose of economic development, trade and industrialization policy were subject to plan priorities. Phase 143

5 I of import restriction and import substitution covers the period of three Five Year Plans ( to ) and the Three Annual Plans ( ). In general, during the post independence period and up to the end of First Five Year Plan ( to ), the import policy was liberal so as to meet the pent up demand released after the Second World War as there was availability of sufficient sterling balances. The strategy of long term planned development was spelt out in the Second Five Year Plan(1956/ /61) which gave a high priority to industrialization. As the draft outline of this Plan was prepared by P. C. Mahalanobis, it is also referred to as Mahalanobis strategy of development. The Second Plan emphasized the strategic importance of the manufacturing and the capital goods sector. Since India was in its early stages of development, it had to rely heavily on import of capital goods, so the emphasis was on replacing these capital goods with domestic import substitution production. There were two options for production strategies : one to substitute the imports of consumer goods by domestic production of consumer goods, and allocate a large part of the investment to the production of consumer goods. The second strategy was to restrict the availability of luxury consumer goods to the minimum, either through domestic production or through import, and expand the base for capital goods through import substitution so that the capability of the economy to produce both consumer goods and capital goods at a future date could be very high. It was the vision of Jawaharlal Nehru, the then Prime Minister of India, that India adopted the later strategy on the ground that it would give India a sound foundation for development, though it implied considerable sacrifices on the part of the Indian people in the early stages of development. After accepting the strategy of import substitution there were two alternative approaches to the implementation of the import substitution : one was 144

6 based upon the use of fiscal and monetary policies such as tariffs, taxes, interest rate policies, etc. which could provide adequate protection to the domestic industry for encouraging competitive production for import substitution. The other was adoption of physical interventionist policies such as licensing, quotas, banning of imports, etc of imports and also adopting some tariff and non tariff measures for providing protection. It was possibly, the severe foreign exchange crisis of and the urgency for adopting strict measures for import control that necessitated the policies which were heavily loaded with interventionist character. In this context, Sen (1982) remarks At a policy level, attempts to induce industrialization in India during the Second Five Year Plan ( ), incorporated a scenario where both capital goods (including intermediate products) and consumer goods production could potentially substitute for imports. In the absence of cost reducing techniques, additional production was only feasible with only protection, which was readily provided by the government through tariff and non tariff restrictions on imports. 2 The policy of import restriction and import substitution was formulated by keeping in view the limited foreign exchange reserves of the country, shortage of essential consumer goods, requirements of capital goods, machinery, spare parts and components for the building up of heavy and basic industries, and the role and scope of import substitution in the country. Moreover, the country had to import food grains to overcome shortages of food grains. All this led to substantial increase in foreign exchange expenditure. The export earnings continued to be stagnant. Hence, the government had no option but to severely curtail import expenditure. Therefore, the history of severe import restrictions in India starts from the year onwards. Given the acute shortage of foreign exchange most of the time, 145

7 policymakers opted for direct allocation of foreign exchange among different users and uses through import licences. In general, the adoption of import substitution strategy was based on four premises : it was believed that only after industrialization had proceeded some way that increased production would be reflected in larger export earnings; that given the large domestic market, exports need not be an engine of growth. growth in external demand for India s products was likely to be inelastic because of the traditional nature of our exports; and the Prebisch Singer argument that primary commodity exports face a secular deterioration in terms of trade. As Rangarajan (1994) noted - As we embarked on a period of planning, during the fifties, import substitution came to constitute a major element of India s trade and industrial policies. Planners more or less chose to ignore the option of foreign trade as an engine of India s economic growth. This was primarily due to the pessimistic view taken on the potential for export earnings. A further impetus to the inward orientation was provided by the existence of a vast domestic market. 3 Thus, import substitution was considered as a correct and inevitable strategy for a continental economy such as India. The Government supported and adopted import substitution or inward oriented strategy throughout our earlier decades of economic planning. This import substitution strategy was supported by use of monetary and fiscal policies, tariffs, taxes, and interest rate policies and physical interventionist policies such as licensing, quota, tariff and non tariff barriers of import restrictions. In other words, export pessimism permeated the policy stance throughout the early decades of our planning. 146

8 The approach of licensing, quotas, etc. intensified in the late fifties and early sixties and led to the creation of a number of institutions such as Chief Controller of Imports & Exports Office, the regional offices, agencies issuing essential certificates, indigenous clearance certificates, etc. In a nutshell, the two broad objectives of the import substitution policy were : to save foreign exchange for the import of more important goods, and to achieve self reliance in the production of as many goods as possible. The Third Five Year Plan (1961/62 to 1965/66) explored the possibility of supplementing export earnings with external assistance. During and after the Third Five Year Plan, export targets were set in various Plan documents and export promotion policies were introduced. However, the goals set for both import substitution and export promotion, continued to influence the policy decisions till about the mid sixties. In this context, Panchamukhi (1987) observed The period from 1962 to 1966 could be identified as a period of induction of export orientation along with heavy import substitution orientation strategies. 4 One of the important decisions taken in June 1966 was the devaluation of rupee by 36.5 percent. b It was accompanied by the elimination of export subsidies, some increase in export duties, and a reduction in tariffs, which reduced the effectiveness of devaluation. It is argued that the devaluation was seen as having been imposed by external pressures. During this period, there was a concerted effort by the United States, the World Bank and the IMF to use external assistance as an instrument to induce India (a) to adopt a new agricultural strategy and (b) to liberalize its network of industrial and trade controls and to devalue the rupee. The trade liberalization measures of 1966 appeared to be extensive, but their effective coverage was more limited. Import liberalization was offered to 59 priority 147

9 industries consisting of export industries, capital building industries, and industries catering to the needs of the common people like sugar and cotton textiles. The year 1966 also saw the initiation of the new agricultural strategy as the need to achieve domestic self sufficiency in food grain production became a paramount policy aim. The government had to resort to large scale import of fertilizers, agrochemicals, seeds, pesticides, and insecticides, etc. to implement the new strategy later termed as Green Revolution. However, the import liberalization measures initiated in 1966 were short lived and from 1968 onwards, the approach of import controls, licensing and restrictions was reintroduced and a variety of export policies were also initiated Important Features of Import Restrictive and Import Substitution Policy Some of the notable features of the import restrictive policy during the period from 1950s to 1970s are as follows - An import licence allowed a specified amount of a specified item to be imported by a specified user for a specified purpose sometimes even from a specified source of supply. Imports were divided into different categories namely, consumer goods, intermediate goods and capital goods. Further, each category was sub divided into non permissible(banned), limited permissible (with mandatory certification and mandatory clearance from the Chief Controller of Exports & Imports (CCI & E), automatic permissible (without mandatory certificate but with clearance from the CCI & E, and open general licence (OGL) without certification and without clearance from CCI & E. 148

10 Licences were also categorized on the basis of user type such as established importer, actual user, newcomer, ad hoc, export promotion scheme etc. Some of the imports were allowed only through state trading agencies like State Trading Corporation (STC), Minerals & Metals Trading Corporation (MMTC), etc. and these were known as canalized items. Quantitative Restrictions were high and liberal for capital goods imports, and zero, low and rigid for the imports of non essential consumer goods. The operation of this cumbersome policy required comprehensive details and a complex administrative mechanism Performance of Balance of Payments in Phase I Phase I (1950s to 1970s) of the trade policy was mainly characterized by import restriction and import substitution. It covers the first three Five Year Plans and the Annual Plans. The key components of India s Balance of payments from the First Plan to Annual Plans are given in Table 5.1 As is evident from Table 5.1, in the first Five Year Plan ( ) India did not experience any serious payments difficulties. Over this period, the total trade deficit which was a little more than `.540 c crore per annum, was financed largely by net invisibles (92 percent). A very small deficit on current account of `.40 crore, was in turn, financed by inflow of external assistance and depletion of foreign exchange reserves in almost equal proportions. During the Second Plan ( ) there was a dramatic change in the balance of payments situation. Throughout the Second Plan, exports were stagnant and the value of imports was almost double the value of exports. As we adopted the strategy of import substitution and high level of investment, there was a huge increase in the trade deficit which went up to `.2250 crore. During this period, the invisibles were 149

11 able to finance about 25 per cent of this trade deficit. Similarly, the current account deficit (CAD) increased to `.1650 crore. This CAD was mainly financed by external assistance (40 percent) and by depletion of foreign exchange reserves (35 per cent). Table 5.1: Key Components of India s Balance of Payments : Plan - wise Total Particulars Merchandise A)Exports f.o.b B)Imports c.i.f. First Plan ( ) Second Plan ( ) Third Plan ( ) ( In ` Crore) Annual Plans ( I. Trade Balance ( A B ) II. Invisibles Net III.Current Account ( I + II ) IV. Capital Account ( A to C ) A)Foreign Investment net B)External assistance, net C)Other capital V. Overall Balance ( III + IV) VI. Monetary Movements ( VII + VIII + IX) VII. Reserves ( increase - / decrease + ) VIII. IMF net IX.SDR Allocation Source: Reserve Bank of India Handbook of Statistics on Indian Economy,

12 The Third Five Year Plan ( ), witnessed a modest growth in export earnings. This was a distinct break from the stagnation of exports during the 1950s. During the Third Five Year Plan, we had to resort to large scale of imports of foodgrains due to unfavourable monsoons. Hence, the overall trade deficit during this period was `.2400 crore. However, the net invisibles showed a decline and were able to finance slightly more than 15 per cent of trade deficit. The CAD of `.1990 crore was mainly financed by external assistance (98 per cent). During the Three Annual Plans ( ), there was a slight decline in trade deficit to `.2130 crore which could be mainly attributed to a decline in imports. However, there was a massive decline in invisibles to `.71 crore. The CAD of `.2060 crore was once again mainly financed by external assistance. Table 5.2 considers key indicators of India s Balance of payments (Plan wise: Annual Average) as a percent of GDP. As is evident from Table 5.2 the trade deficit, (TD) to GDP ratio increased from 1.1 to 3.3 from the First Plan to Second plan. During the Third plan and Annual Plans it declined and remained stagnant at 2.2 percent of GDP. The CAD / GDP ratio which was a meagre 0.1 percent in the First Plan, increased to 2.4 percent during the Second Plan. It slightly declined during the Third and Annual Plan periods. Another notable feature was a decline in the import cover from 15 to 5 from First Plan and further to 3 during the Third and Annual plan periods. Furthermore, the export / import ratio too declined from 85 to 60 from the First Plan to the Annual Plan periods. 151

13 Sr. No. Table 5.2: Key Indicators of India s Balance of Payments : Plan wise Annual Average (As Per cent of GDP) Particulars First Plan ( ) Second Plan ( ) Third Plan ( ) Annual Plans ( Exports Imports Total Merchandise trade Trade Deficit Current Account Deficit Import Cover of Reserves ( in months) Annual average 7 Export / Import Ratio Source : Reserve Bank of India : India s Balance of Payments to & Reserve Bank of India Bulletin (Various issues) Evaluation of Trade Policy in Phase I The important features of trade policy in Phase I & its effect on balance of payments can be summarized as follows:- This period was marked by three wars (1962 with China, and 1965 & 1971 with Pakistan). The Indian economy faced the first macroeconomic crisis between During this period, the balance of payments deteriorated because of the two severe droughts in succession ( and ), which further led to an increase in food imports and reduction in primary product exports. This weakness of the balance of payments and the shortage of food increased the economy s dependence on foreign aid. To overcome the crisis, the government undertook three important policy measures (a) firstly, a restrictive fiscal policy was adopted, (b) secondly, the rupee was devalued in June 1966, along with import liberalization and rationalization of import duties and export subsidies, and (c) thirdly, a new 152

14 agricultural strategy was adopted which encouraged the use of fertilizers and high yielding variety seeds. The measure of devaluation was highly criticized, though considered as a correct long term measure, its timing was improper because it was determined by the momentum of negotiations and not by the objective of economic situation. The favourable effects of devaluation were swamped by the drought and the balance of payments situation further deteriorated in and Finally, the balance of payments situation did improve after , but it was mainly because of agricultural recovery in 1968, that led to a decline in food imports and capital goods imports. Overall there was slow growth in exports in relation to import requirements which was partly because of adverse external factors Critical Appraisal of Trade Policy of Phase I The impact of trade policy of Phase I on industrial development, exports, and certain macroeconomic indicators is as follows : (a) Effect on industrial development : The trade policy of Phase I which was mainly based on import substitution no doubt succeeded in achieving the objective of industrialization and saving of foreign exchange. This inward looking strategy of industrialization resulted into high rates of industrial growth between 1956 and For instance, there occurred a noticeable acceleration in the compound (annual) growth rate of industrial production over the first three Plan periods up to 1965 from 5.7 per cent in the First Plan to 7.2 per cent in the Second Plan and 153

15 further to 9.0 per cent in the Third Plan. Moreover, the rate of growth of capital goods industries shot up considerably from 9.8 per cent per annum in the First Plan to 13.1 per cent per annum in the Second Plan and further to 19.6 per cent per annum in the Third Plan. The rate of growth of basic goods industries also registered a significant increase from 4.7 per cent per annum in the First Plan to 12.1 per cent per annum in the Second Plan and stood at 10.4 per cent in the Third Plan. 5 This shows that a strong base for industrial development was laid during the first three plan periods. During the trade policy of phase I, the long term growth rate of industrial production works out to be 7.7 per cent over the first three plan periods and 4.0 per cent during the three Annual Plans. 6 (b) Effect on exports : It is argued that the trade policy discriminated against exports which led to poor export growth. As a result, there was consistent fall in exports as a proportion of GDP until the early 1970s. For instance, exports as a per cent of GDP fell from 6.4 per cent in First Plan to 4.2 per cent by the end of three Annual plans. Moreover, Indian exports as a proportion of world exports fell from 2.5 per cent in 1947 to 2 per cent in 1950 and further to one per cent by Thus, most of decline in Indian exports was caused by our own policies rather than external factors. (c) Effect on Macroeconomic indicators: (a) The Gross Domestic Savings / GDP ratio was 9.6 per cent in 1950s which further increased to 12.3 per cent in 1960s. Similarly, the Gross Domestic Capital formation / GDP ratio was 10.8 per cent in 1950s, which further went up to 14.3 per cent in 1960s. (b) The Saving Investment Gap / GDP ratio was 1.2 per cent in 1950s, which increased to 2.0 per cent in 1960s. (c) A notable impact can be seen on the inflation rate which increased from 154

16 1.2 per cent in 1950s to 6.4 per cent in 1960s. (d) From 1950s to the end of 1960s, there was stagnation in the growth rate of Real GDP. For instance, In 1950s, the average annual growth rate of Real GDP was 3.6 per cent while in 1960s it was 4.0 per cent. 8 (d) Other weaknesses : Some of the other weaknesses of the trade policy followed in phase I were : (i) administrative delays and inflexibilities; (ii) lack of coordination among different agencies; (iii) absence of competition; (iv) protection to industries regardless of cost; and (v) loss of revenue Phase II Export Promotion & Import Liberalization (From 1970s to 1990s) Phase II of export promotion & import liberalization covers the period from Fourth Plan ( to ) to Seventh Plan ( to ). One of the important features during the second phase is that the year initiated a new era of import liberalization in the country and the process was further carried forward in 1980s. After taking into account the defects of import substitution policy, the policy makers realized that there was a need to correct the anti export bias which dominated the formulation of trade policy till 1970s. A revival of export promotional methods which started gaining momentum resulted in an Export Policy resolution by the Cabinet Committee as early as in Thus, during seventies, several export promotion measures were put in place to generate higher exports on a sustained basis. In this context, Panchamukhi (1987) noted From 1971 onwards, a new dimension to the export promotion effort was added in the form of creation of a number of organizations aimed at providing export services to the exporting 155

17 community. Creation of export promotion councils, commodity boards, and the Trade Development Authority in the early 1970s signifies these developments. 9 The export promotion measures undertaken in the seventies implied a gradual shift in the policy stance from import substitution to export promotion. However, protective quotas remained more or less same, and the domestic industry continued to be protected from import competition. In the early eighties, foreign trade policy issues became a matter of intensive discussion among the policymakers in India. It was realized that import licensing scheme which permitted imports to cover the shortfall in domestic demand, irrespective of difference in cost and prices, could only lead to inefficiency. Therefore, a more liberal policy of imports of capital goods and technology was necessary to get the benefits of international division of labour. It was realized that there was a need to move away from a policy of import substitution per se to efficient import substitution. Further, it also became increasingly clear that production for export could not be isolated from production for the domestic market and that trade policy had to be integrated with the policy for domestic industrialization. It is pertinent to note that during seventies and eighties, the changes in trade policy were also influenced by the recommendations of a number of committees which were set up during the said period. Three important committees were (1) Alexander Committee (1978) (2) Tandon Committee (1980) and (3) Abid Hussain Committee (1984). The Alexander Committee (1978) 10 recommended simplification of the import licencing procedures and provided a framework involving a shift in the emphasis from controls to development. In a nutshell, it had recommended replacement 156

18 of the licensing system by the tariff system, rationalization of export incentives, elimination of multiplicity of incentives, more liberal access to imports by exporters, coordination of the different policy instruments such as trade policies, industrial policies, monetary and fiscal policies, strengthening of the institutional infrastructure for export promotion, judicious combination of exports and import substitution etc. On the basis of the recommendations of the Alexander Committee, selective import liberalization measures were initiated in the late seventies which aimed at import of capital goods easier. Similarly, imports of certain raw materials that were not available indigenously were also placed under the Open General Licence (OGL) list. The policy measures also gave emphasis to simplify the procedures governing India s foreign trade. During this period, special measures were undertaken to boost the export of project goods. The Tandon Committee (1980) 11 was more explicit about the desirability of export promotional devices. It recommended a package of export promotional measures which included subsidies and fiscal concessions to exporters. The Committee suggested that there was a need for having an integrated approach towards the export activity right from production upto the marketing stage and export planning at the national level, state level and the corporate level should become an integral part of the decision making process. The following abstract from the Tandon Committee s Report (1980) sums up the official position in India on exports during the early 1980s - Rapid export growth will undoubtedly help the overall rate of growth of the economy because of efficiency gains obtained from the pursuit of dynamic comparative advantage and the flexibility regarding foreign exchange availability. The emphasis on exports is viewed as a case for reallocating future investment of resources from import substitution to export promotion in a manner consistent 157

19 with dynamic comparative advantage for allocating productive resources optimally between import substituting production and export oriented production. 12 There were two main reasons behind advocating export promotional strategy. The first reason was that it would increase export earnings. The second reason was that it would allocate resources efficiently. Thus, the policy which combined export promotion and import liberalization was looked upon as a second best remedy which could be achieved in the face of prevailing distortions in the domestic economy. It clearly favoured liberalization of trade and encouragement of other conditions to achieve dynamic comparative advantage. The main message of the Abid Hussain Committee s Report (1984) 13 seems to emphasize the importance of exports and rational export promotion policies. The Committee envisaged growth led exports rather than export led growth. It suggested simplification of the import policy for exporters by the introduction of the pass book system. It also recommended that canalization of imports should be effected on a selective basis, based upon rational criteria. It recommended that the real effective exchange rate (REER) of the rupee should not be allowed to appreciate and should be maintained at a level considered appropriate for ensuring the competitiveness of exports. It stressed upon the need for harmonization of foreign trade policies with other economic policies and advocated for a phased reduction of effective protection. In order to maintain continuity and facilitate long term planning of exports, the Committee also suggested announcement of trade policies for longer periods. The Committee stressed on export promotion and import liberalization especially of technical know how through foreign equity participation in India. It was believed that a free flow of foreign direct investment would contribute to higher exports and lead to technological innovations in the export sector. 158

20 A comparative picture of the trade policy changes from 1950s to 1980s is rightly shown by Mehta (1997) as follows - While the objectives of self reliance and self sufficiency influenced the trade policy formulation in the 1950s and 1960s, the factors like export led growth, improving efficiency and competitiveness of Indian industries prevailed upon the trade policy making during the late 1970s and the early 1980s. 14 The recommendations given by the above three Official Committees were implemented by the Government in the annual as well as long term policy announcements in ensuing years. Accordingly, for the first time a three year long term import export (LTMX) policy covering the period was announced on 31 st March 1985, with an objective of bringing in continuity and stability in import export policy. This policy was formulated with the aim of boosting exports and encouraging efficient import substitution. Subsequently, also three year policies were announced, but each time the policy was cut short by one year. However, for the first time in trade history, a five year Export & Import (EXIM) Policy was announced by the Government of India on 31 st March, The announcement of the new EXIM policy covered the five year period from April 1992 to March 1997 and it coincided with the launching of India s Eighth Five Year Plan (1992/93 to 1996/97). In a nutshell, the trade liberalization measures undertaken especially after 1985 were directed towards two goals - To provide easy access to imports essential for maximizing production and exports ; To gradually open up the economy and make selective capital goods industries internationally competitive. 159

21 The first three yearly import export policy ( ) which coincided with the first three years of the Seventh Plan (1985/86 to 1989/90) therefore saw the injection of a dose of economic liberalization in general and trade liberalization in particular. A major ingredient of the Export Import Policy announced in March 1985 was the provision of easy access to essential capital goods, raw materials and components from abroad since these were viewed as a major incentive for exporters in undertaking technological upgradation for reducing costs and improving quality. In the context of trade policy & trade liberalization, the Annual Report ( ) of Ministry of Commerce, observed The broad philosophy of the trade policy is to encourage production and modernization of the indigenous industry and to encourage international trade in accordance with the India s long term dynamic comparative advantage. Export promotion measures have received special attention during the current plan period. These measures focus on removing the disadvantages faced by Indian exporters and to increase their competitive ability in the foreign markets. The import policy on the other hand, aims to make available critical inputs and capital goods to domestic producers to increase production and to upgrade the existing production technologies Important Import Liberalization Measures Some of the important import liberalization measures undertaken in the first three LTMX policies were - (1) Policy for Import of Capital Goods As capital is considered as basic requirement of the industrial sector, the approach in these policies was to provide easy access to imported capital items by progressively delinking them from licensing formalities. Hence, a large number of capital goods were 160

22 placed under OGL category, that is, they could be imported without any import licence. (2) Policy for Import of Raw Materials A large number of raw materials and components and consumables were also placed under OGL in order to enable the actual users to procure them without going through licensing formalities. (3) Policy for Import of Technology The government also allowed liberal import of technology with a view to make export production of the country internationally competitive and also to help in the country s technological advancement Important Export Promotion Measures Some of the important export promotion measures undertaken by the Government of India during the period 1966 to 1990 were (1) Cash Compensatory Support (CCS) It was introduced in 1966 and was designed to provide compensation for unrebated indirect taxes paid by exporters on inputs, higher freight rates, and market development costs. The rates varied from product to product and from exporter to exporter. However, the scheme was abolished after the devaluation of rupee in July (2) Duty Drawback Scheme The objective of the duty drawback scheme is to reimburse exporters for tariff paid on the imported materials and intermediates and central excise duties paid on domestically produced inputs which entered into export production. (3) Replenishment Licences In order to provide the export sector of the economy with access to importable inputs that enter into export production, at international prices, the import policy allowed special import facilities for 161

23 Registered Exporters. Registered Exporters were permitted to import capital goods against REP (Replenishment) Licenses. (4) Advance Licenses and Duty Exemption Scheme Advance licenses facilitated imports of specified raw materials without payment of any customs duty. Such licenses were available only against confirmed export orders and / or letters of credit. (5) Establishment of Export Processing Zones and 100 per cent Export Oriented Units To encourage exports, the government initiated setting up of Export Processing Zones (EPZs) which provided almost free trade environment for export production so as to make Indian export products competitive in the world market. Further, the scheme of 100 per cent Export Oriented Units (EOUs) was introduced in December 1980 to provide duty free access to imports of raw materials, intermediate goods, capital goods and technology on OGL. (6) Fiscal concessions for exports Export earnings also included fiscal concessions in the form of partial exemption from income tax or lower rate of taxes besides the benefit received through cash compensatory scheme and duty drawback scheme. (7) Export Credit and Assistance to Export Promotion Councils Assistance was granted in the form of grants in aid to the Export Promotion Councils and approved organizations and individual exporters to undertake various activities which would encourage exports. (8) Blanket Exchange Permit Scheme It was introduced in June 1987 to give a major thrust to the country s export promotion drive. Under this scheme, 162

24 exporters were allowed, barring a few products, to utilize 5 to 10 per cent of their foreign exchange earnings for undertaking export promotion activities. (9) Policy for Export Houses Exporters who fulfill certain minimum export requirements for a specified period of time are granted the status of Export Houses, Trading Houses, Star Trading Houses, or Super Star Trading Houses. They were provided increasingly with a number of import benefits. (10) Organisational efforts In order to promote exports various organizational agencies were set up like (a) Export Promotion Councils, (b) Trade Development Authority, (c) Export Credit & Guarantee Corporation of India, (d) Export Houses, etc Performance of Balance of Payments in Phase II The trade policy of Phase II covered the period from Fourth Plan to Seventh Plan. Several important developments took place during this phase like the two oil shocks of 1973 and 1979, increase in foreign exchange reserves, increase in the current account deficit, etc. These developments affected various indicators of balance of payments. Table 5.3 depicts the balance of payments data from Fourth Plan to Seventh Plan. As is evident from Table 5.3, during the Fourth plan there was a decline in trade deficit to `.1730 crore and a massive increase in invisibles to `.1375 crore. Hence, the invisibles were able to finance almost 80 per cent of the trade deficit. There was a decline in the CAD to the extent of `.350 crore. It was mainly financed by external assistance. In fact yearly data of BOP during the Fourth Plan reveals that there was a surplus in current account to the extent of `.1135 crore in the year The Fifth Plan period ( ) can be said to be a period of comfortable situation from India s balance of payments point of view. During the said period, the trade 163

25 deficit was entirely financed by the invisibles. As a result, there was a current account surplus to the extent of `.645 crore. Besides this there was a massive increase in foreign exchange reserves as compared to the earlier plan period. For instance, the foreign exchange reserves increased from `.295 crore in the Fourth Plan to `.4780 crore in the Fifth Plan. This period can be said to be the golden years from the India s balance of payments point of view. Table 5.3 Key Components of India s Balance of Payments : Plan - wise Total ( In `. Crore) Particulars Fourth Plan ( ) Fifth Plan ( ) Sixth Plan ( ) Seventh ( ) Merchandise A)Exports f.o.b B)Imports c.i.f I. Trade Balance ( A B ) II. Invisibles Net III.Current Account ( I + II ) IV. Capital Account ( A to E) A)Foreign Investment net B)External assistance, net C)Commercial Borrowings, net D) NRI Deposits, net D) Other capital V. Overall Balance ( III + IV) VI. Monetary Movements ( VII + VIII + IX) VII. Reserves ( increase - / decrease + ) VIII. IMF net IX.SDR Allocation Source : Reserve Bank of India Handbook of Statistics on Indian Economy,

26 As is evident from Table 5.3, the comfortable position of BOP of the Fifth Plan could not continue in the Sixth plan ( ). In fact, the Sixth Plan revealed several peculiar features of the balance of payments. Some of the important features were First, during the Sixth plan, exports nearly doubled while imports increased by more than two fold as compared to the Fifth plan ; Second, the resultant trade deficit increased nearly by six times as compared to the previous plan. As depicted in Table 5.3, the trade deficit increased from `.5590 crore in the Fifth plan to `.33,000 crore in the Sixth plan; Third, compared to the Fifth plan, invisibles showed an increase of three fold which could finance almost 55 per cent of trade deficit; Fourth, a small surplus in the current account during the Fifth plan turned into a massive deficit of `.14,500 crore in the Sixth plan ; Fifth, there was almost four times increase in the commercial borrowings and NRI deposits. Moreover, both of them are considered to be costlier sources of finance. Sixth, the current account deficit was mainly financed by external assistance, (38 per cent), borrowings from IMF, (28 per cent), commercial borrowings (20 per cent) and NRI deposits. (14 per cent). Table 5.3 shows that the balance of payments situation worsened in the Seventh plan ( ) period. Some of the important features of the balance of payments situation during the Seventh plan were As compared to the Sixth Plan, both exports and imports nearly doubled during the Seventh plan period; 165

27 The resultant trade deficit of `.54,200 crore showed an increase of more than one and half times compared to the previous plan period; Invisibles however showed a decline and were able to finance only about 25 per cent of the trade deficit ; The current account deficit increased by more than two and half times as compared to the previous plan. It increased from `.14,500 crore in the Sixth plan to `.41,000 crore in the Seventh Plan. The use of external assistance, commercial borrowings and NRI deposits as sources of finance increased considerably during the Seventh plan. On the one hand, the use of external assistance more than doubled, while the use of commercial borrowings and NRI deposits more than quadrupled. In a nutshell, the use of costlier sources of financing increased substantially in the Seventh plan. In fact, almost 88 per cent of the current account deficit was financed by external assistance, commercial borrowings and NRI deposits. There was a massive decline in the foreign exchange reserves to the extent of `.5000 crore in the Seventh plan period. As shown in Table 5.4, TD / GDP ratio was 0.7 in the Fourth Plan which further increased to 1.2 in the Fifth Plan. However, this ratio doubled in the Sixth plan to 3.5 and remained more or less same in the Seventh plan. The CAD / GDP ratio was a meagre 0.3 in the Fourth plan, which turned into a surplus of 0.1 in the Fifth plan. The current account once again turned into a deficit in the Sixth plan and the CAD / GDP ratio went up to 1.5 in the Sixth plan and further increased to 2.2 in the Seventh plan period. The import cover of foreign exchange reserves showed a slight improvement from 5.2 in the Fourth plan to 6.7 in the Fifth Plan. However, it 166

28 declined to 4.1 in the Sixth plan and further to 3.4 in the Seventh plan. The export / import ratio which was about 80 per cent in the Fourth and Fifth plan, too declined to about 60 per cent in the Sixth and Seventh plan period. Sr. No. Table 5.4: Key Indicators of India s Balance of Payments : Plan wise Annual Average (As Per cent of GDP ) Particulars Fourth Plan ( ) Fifth Plan ( ) Sixth Plan ( ) Seventh ( ) 1 Exports Imports Total Merchandise trade Trade Deficit Current Account Deficit Import Cover of Reserves ( in months) Annual average 7 Export / Import Ratio Source: Reserve Bank of India Handbook of Statistics on Indian Economy, Impact of the Oil shocks on India s Balance of Payments One of the crucial factors which affected India s BOP during the decades between 1970s and 1980s was the emergence two oil shocks in 1973 & (1) First oil shock 1973 & its management One of the exogenous factors which affected India s BOP during the Fourth Plan was the first oil shock of The Organisation of Petroleum Exporting Countries (OPEC) resorted to a substantial increase in the price of crude oil from $2.50 per barrel in October 1973 to $ per barrel in January Its direct impact was a massive escalation in the foreign exchange expenditure on oil imports which, in turn, imposed a severe pressure on the balance of payments. For instance, India s oil imports increased from `.204 crore in , to `. 560 crore in , and further to `.1157 crore in

29 Apart from this the country had to resort to import of fertilizers, and foodgrains during the same period, which further aggravated the import bill. Thus, Joshi & Little (1994) observed that - there can be no doubt that the and were crisis years. The crisis had a political component and the macroeconomic component, and the latter in turn had an inflation component as well as balance of payments component. 16 Thus, the Indian economy faced second macroeconomic crisis between 1973 and The immediate effect of this shock was the widening of CAD, which increased from `.312 crore in to `.956 crore in (Table 5.5). There was also domestic inflation due to severe droughts of 1972 and Besides this, the disturbed political situation led to imposition of national emergency by Mrs. Indira Gandhi in June Management of first oil shock The first oil shock was managed well due to following factors - To overcome the crisis, the import controls were tightened in and and measures were undertaken to restrain the consumption of petroleum products. On the export front, India s exports grew rapidly, in the years and , in spite of stagnancy in world trade and decline in the exports of non oil developing countries. It would be pertinent to note that despite the first oil shock of 1973, the current account showed a surplus of `.1135 crore in The reduction of CAD to `.178 crore in , was a dramatic change. In the years and there was a surplus in the current account of `.890 crore and `.1120 crore respectively. However, the current account 168

30 went into deficit again in (`.238 crore), but overall the balance of payments remained comfortable. (Table 5.5). Besides the import control measures, in the early stages the shock was mainly financed through substantial borrowings from the soft facilities of IMF like CFF, low conditionality credit and oil facility. d In addition, there were bilateral and multilateral grants and loans. However, these borrowings were mainly concessional and there was no borrowing from commercial sources. On the fiscal front, there was a control over the government s current expenditure through a restrictive fiscal policy accompanied by a tight monetary policy. Table 5.5: Current Account of India s Balance of Payments to 1979 (In `. Crore) Particulars Merchandise A)Exports f.o.b B)Imports c.i.f I. Trade Balance ( A B ) II. Invisibles Net III.Current Account ( I + II ) Source: Reserve Bank of India Handbook of Statistics on Indian Economy,